The December 12, 2007 National Post article, "David Dodge Sounds Alarm," quotes the Governor of the Bank of Canada as follows:
"All Canadians could pay a price if banks fail to come up with an agreement to save the troubled sector of the country's debt market and $300-billion worth of leverage is allowed to unwind in a worst-case scenario, David Dodge, governor of the Bank of Canada, said yesterday. If the whole market goes into a shambles everybody gets affected, including Mr. and Mrs. Jones on Main Street," said Mr. Dodge. "We have a collective interest in the whole thing not going into a shambles."

In my opinion, the banks should offer the solution, where they take the newly restructured long term notes and they offer cash settlements to the current owners at par, (except for the Caisse due to its dominance in the Non Bank ABCP market and its conflict of interest as an owner of Coventree and modest discounts for ABCP Series Notes not backed by any liquidity agreement). Then, the banks can take possession of, on their own balance sheets, the AAA rated collateral assets and the leveraged credit default swap liabilities under settlement arrangements amongst themselves, that avoids the fire sale of $300 billion worth of AAA rated collateral assets and CDS reference AAA asset portfolios. The banks should upon taking the restructured long term notes onto their own balance sheets, take the marked to market writedowns on the underlying net assets. As noted in my independent research report, "Another Made-in-Canada Defective Investment Product," dated November 23, 2007, the banks can afford to take the writedowns, as the after tax loss would likely be between -4% and -8% of their total shareholders equity.

The banks agreeing to this solution, that I illustrate by schematic above, would demonstrate the same leadership that J.P. Morgan exhibited in the U.S. Financial Panic of 1907, where the major U.S. banks agreed to bailout several trusts that were suffering runs by depositors, who feared the loss of their money when the net assets within the trusts were becoming impaired in value. These U.S. banks volunteered to make the trust depositors whole even when they had no legal obligation to do so. In the current Canadian Non Bank ABCP crisis, the ABCP short-term lenders are akin to the depositors in the trusts during the Financial Panic of 1907. The difference in circumstances within Canada today, is that the domestic banks(excluding possibly the TD Bank) and the foreign divisions of international banks were themselves, or their subsidiaries, directly involved in the manufacturing or distribution of the frozen Non Bank ABCP that were designed and sponsored by entrepreneurial conduit firms. Some Canadian banks and the list of international banks in the Montreal Accord became involved in the manufacturing of the Non Bank ABCP trusts, when they became buyers of the leveraged credit default swaps or the signatories for the "no use" liquidity agreements. In most cases, the bank who bought the credit default swaps with the claims for default damages and subsequent rights to the AAA collateral assets, was the same bank that signed the "no use" liquidity agreements. This simultaneous contracting by the banks was not fair dealing and not disclosed to the Non Bank ABCP owners.

The banks offering the solution I suggest is not a case comparable to J.P. Morgan organizing a bank bailout of trusts that they were not legally required to do. Owners of the Non Bank ABCP today do have legitimate legal claims for remedy from the banks for negligent misrepresentation related to the manufacturing or distribution of the Non Bank ABCP trusts. If J.P. Morgan and the banks existing in 1907 had the where with all to make a voluntary bailout of the trusts, when they had no legal obligation to do so, to avoid a financial crisis, surely the Canadian and international banks that have legal liability for their direct or subsidiary involvement with the Canadian Non Bank ABCP trusts can step to the plate to come up with an agreement with Canadian pension funds, governments and corporations that are stuck with this defectively designed commercial paper of uncertain current value.

The way I see it, just because the securities guard is asleep does not mean you are entitled to rob the bank. The pension fund portfolio managers, government and corporation treasurers could have asked more questions, but the banks should not have sold a product negligently or with deceit that has Canadian pension beneficiaries, shareowners and taxpayers being robbed of their cash. The money managers and treasurers working for Canadians did not invest in money market instruments for high investment returns, but to achieve capital preservation while they waited for its long term deployment in corporate projects, public infrastructure and services and the purchase of long term investments such as stocks, bonds and real estate.

Last June, an investor called Ron believed the stock market was overvalued and asked his adviser to sell most of his mutual funds.

"The timing seemed excellent as the market correction arrived shortly after," he says.

But Ron failed to discuss with his adviser what to do with the sale proceeds.

The money ended up in a 30-day money market investment, which was called Rocket Trust on his monthly statement.

The adviser said Rocket Trust notes had a AAA rating, better than many government bonds.

But after 30 days, the adviser called to say the funds weren't available and had to be rolled over for another six months.

"I was fine with this. The stock market was still unstable and I was looking for a safe haven," Ron says.

"But after doing a bit of research on Rocket Trust, I see it's part of the Coventree asset-backed commercial paper (ABCP) quagmire.

"How worried should I be that I am exposed to ABCP?"

This Friday, a blue-chip committee will report on its efforts to restructure Canada's $35 billion market in non-bank ABCP – mostly in trusts run by independent issuers such as Coventree Capital Group of Toronto.

The original October deadline was extended. Everyone hopes that Montreal lawyer Purdy Crawford and investment bank JPMorgan Chase will be able to wring concessions from international banks and get the market moving again.

Small investors like Ron can hardly be blamed for not knowing what they got into.

The information memorandum about Rocket Trust, available at Coventree's website, is 18 pages of bafflegab, clarifying nothing. There was no indication that any assets were linked to the U.S. subprime mortgage market.

It was easier to rely on the AAA rating conferred by Dominion Bond Rating Service, whose report is also at Coventree's website.

Only after the crisis blew up did it become widely known that DBRS was the only bond rating agency that would rate such debt. The other agencies, such as Moody's and Standard & Poor's, stayed away.

DBRS said the Rocket Trust notes had liquidity lines to cover market disruptions – a strength. It also said the liquidity lines were limited to market disruption – a challenge.

With such equivocation, how could investors or advisers rate the rating agency's AAA rating?

Only later did it become known that the liquidity backstop for these securities was less complete in Canada than elsewhere.

International banks had to buy back the assets only if there was a market disruption severe enough that commercial paper issuers could not issue anything at all. That never happened.

Ron bought his Rocket Trust notes from Credential Securities, a firm that is owned by the credit union movement in Canada.

Credit unions market themselves as more ethical and customer-friendly than banks. But even they are not immune to the money market contagion.

A merger between two of Canada's largest credit union organizations, Credit Union Central of Ontario and Credit Union Central of British Columbia, has been held up because of their holdings of ABCP.

Though the amounts were small ($161 million for Ontario and $23 million for B.C. out of total assets of $7.5 billion), no one could put a price tag on the ABCP portfolios because the market is frozen. So the merger has been put off from the original date of Oct. 1, 2007.

Meanwhile, Coventree has had to make major cuts in its workforce to trim costs. Its stock is trading at just $1 – or 94 per cent below its 52-week high of $16.30.

All eyes will be on Montreal this week when the committee releases its report. Let's hope the uncertainty that has lingered since August will finally start to clear up.

--------------------------------------------------------------------------------
Ellen Roseman's column appears Wednesday, Saturday and Sunday. You can reach her by writing Business c/o Toronto Star, 1 Yonge St., Toronto M5E 1E6; by phone at 416-945-8687; by fax at 416-865-3630; or at eroseman@thestar.ca by email

Wall Street Firms Are Subpoenaed
New York Examines Treatment
Of Debt Tied to Risky Mortgages
By KARA SCANNELL
December 5, 2007; Page C2
New York state prosecutors have sent subpoenas to several Wall Street firms seeking information related to
the packaging and selling of debt tied to high-risk mortgages, people familiar with the matter say, the latest
legal woe to hit the stressed industry.
The subpoenas, sent by the office of New York state's attorney general, Andrew Cuomo, are broadly written
and request information from firms including Merrill Lynch & Co., Bear Stearns Cos. and Deutsche Bank AG,
people familiar with the matter say.
The review, part of a broader investigation into the mortgage industry, is examining how
adequately the investment banks reviewed the quality of mortgages before packaging
them into products that were then sold to investors, these people say. The subpoenas
also requested information about how the debt was pooled into securities, including the
banks' relationship with credit-rating firms.
A spokesman for Mr. Cuomo couldn't be reached. A Merrill spokesman declined to
comment on the subpoena, saying: "We always cooperate with regulators when asked to
do so." Bear Stearns and Deutsche Bank declined to comment.
The state-prosecutor inquiry is the latest twist in the fallout stemming from residential
subprime mortgages. A rise in defaults and foreclosures, particularly among low-end
borrowers, has whipsawed global stock and bond markets, led to the dismissal of two
Wall Street chief executives, and resulted in losses by banks, hedge funds and securities firms. The
Securities and Exchange Commission has opened about two-dozen investigations stemming from the
collapse of residential subprime mortgages, a person with knowledge of the situation said. In addition, the
role of credit-rating firms is being examined by federal and state regulators.
The role being played by Mr. Cuomo's office is reminiscent of the path taken by his predecessor, Eliot
Spitzer, who as New York attorney general shined a spotlight on conflicts of interest on Wall Street, trading
abuses at mutual funds and bid-rigging at insurance companies.
The inquiry into what role securities firms played in the current crisis is likely to look at Wall Street's
underwriting standards. In particular, the probe appears to be examining the relationships between
mortgage companies, third-party due-diligence firms, securities firms and credit-rating firms.
The inquiry raises questions about the extent to which securities firms are obligated to dig into the
mortgages before slicing them up to sell to investors. Many securities firms rely on third-party vendors to do
this work; among the questions is whether this effort was adequate, or if securities firms had a duty to do
further due diligence. Securities firms that underwrite securities have an obligation to make sure that
statements included in offering documents are accurate.
In a news conference last month announcing subpoenas to mortgage giants Fannie Mae and Freddie Mac,
Mr. Cuomo said "investment banks wanted the mortgages." That suggests he is raising questions about
whether banks turned a blind eye to what Mr. Cuomo says were inflated appraisals in order to package and
sell the products to make fees. "The follow-the-money expression is, 'follow the mortgage'" into the
secondary market, Mr. Cuomo said.
Write to Kara Scannell at kara.scannell@wsj.com

UPDATE 4-CIBC stock battered by hedged subprime exposure
Thursday, December 06, 2007 6:09:33 PM (GMT-05:00)
Provided by: Reuters News
(Adds CEO quotes, analyst comment, closing share price)
By Lynne Olver and Nicole Mordant
TORONTO/VANCOUVER, Dec 6 (Reuters) - Canadian Imperial Bank of Commerce <CM.TO> posted an 8 percent jump in
fourth-quarter earnings on Thursday but its stock and reputation took further hits from the U.S. housing-derived credit
crunch.
CIBC shares sank 5.4 percent in heavy volume after it revealed it expects more U.S. subprime mortgage-related
writedowns, and warned of potential "significant losses" from its hedged exposure to the troubled U.S. housing sector.
Chief Executive Gerry McCaughey, who has stressed risk-reduction measures since he took the top job in 2005, said
CIBC underestimated the meltdown of the subprime market.
"This, coupled with an over-dependence on the extremely high ratings of these securities, resulted in the build-up of
exposures that are too large for CIBC's risk appetite," McCaughey said on a conference call.
CIBC, Canada's fifth-biggest bank, said that as of Oct. 31 it had a notional C$9.3 billion ($9.2 billion) of subprime
mortgage exposure through derivatives contracts hedged with unnamed investment-grade counterparties. The fair value
of the hedged contracts was C$4 billion, the bank said.
The impact of economic and market condition changes on counterparties could mean "significant future losses," it said.
The bank "again showed its propensity to misstep," BMO Capital Markets analyst Ian de Verteuil said in a note. He said
CIBC could take another C$2 billion in subprime charges in the first half of 2008.
A number of unknowns in the release stoked fear, said Bruce Campbell, president of Campbell & Lee Investment
Management.
"The question that the market is now trying to come to grips with is what are those hedges, who are the counterparties
and how good are they?" Campbell said.
Shares in CIBC sank C$4.69, or 5.4 percent, to C$82.40 on the Toronto Stock Exchange. The stock is down 16 percent
year-to-date, the second-worst performer among Canadian banks.
CIBC has the largest exposure among Canadian banks to the U.S. subprime sector, which made home loans to customers
with poor credit records, many of whom are now defaulting.
Market conditions have worsened since Oct. 31, CIBC said, and it projected another C$225 million writedown for
November.
But analysts said the C$9.3 billion in hedged subprime derivatives contracts -- or $9.8 billion in U.S. dollar terms on Oct.
31 -- grabbed their attention.
"This is a bit more on the risk side than people were expecting out of CIBC," Edward Jones analyst Craig Fehr said. "A
primary focus for CIBC in recent quarters and going forward has been the de-risking of the bank, and this seems pretty
inconsistent with that message."
Rating agency Moody's changed the outlook on CIBC's debt to negative from stable, citing concern about risk
management. Despite expected improvements, "it now appears the bank has not fully addressed appropriate risk-taking
at a senior, strategic level," Moody's said.
Blackmont Capital analyst Brad Smith said CIBC's disclosure of its gross subprime exposure confirmed market
speculation, and he said several credit insurers have been pressured due to concerns about their ability to honor
counterparty contracts.
CIBC said nearly half its hedged portfolio with exposure to subprime real estate was spread among five triple-A rated
Page 1 of 2
reutersnews://reuters/local?cache=1440&id={65890935-442F-48AB-8121-5F68D6F9DB97} 12/6/2007
guarantors, none of which rating agencies have downgraded. But a big chunk of it, with notional value of US$3.5 billion,
was hedged with one single-A rated counterparty.
Meanwhile, CIBC said it earned a net C$884 million, or C$2.53 a share, for the three months to Oct. 31, up from yearearlier
C$819 million, or C$2.32 a share, with gains driven by its retail business.
CIBC had previously said its unhedged exposure to the subprime market was about US$1.7 billion.
It updated that figure on Thursday, saying its net unhedged exposure to collateralized debt obligations and residential
mortgage-backed securities on Oct. 31 was about C$741 million, or $784 million in U.S. dollar terms.
($1=$1.01 Canadian)
(Reporting by Lynne Olver and Nicole Mordant; Editing by Rob Wilson)

Scotia Capital named in ABCP lawsuits
TARA PERKINS AND JACQUIE MCNISH
FROM THURSDAY'S GLOBE AND MAIL
DECEMBER 6, 2007 AT 6:05 AM EST
Canaccord Capital Corp. is alleging that Bank of Nova Scotia received material non-public information about third-party assetbacked
commercial paper in July and began reducing its own holdings of the paper, even as it continued to pitch the investment to
clients.
The allegations have arisen as part of two lawsuits filed by investors against Canaccord in the Supreme Court of British Columbia.
Canaccord brought Scotiabank into the suits because the bank sold the ABCP to Canaccord, which in turn sold it to companies and
individual investors.
Canaccord named Scotiabank's investment banking arm, Scotia Capital Inc., as a party to the suits, alleging that it made negligent
misrepresentations, failed to warn Canaccord and breached its fiduciary duty.
Scotiabank denies each and every allegation and plans to defend itself vigorously, spokesman Frank Switzer said yesterday.
"Canaccord is a sophisticated participant in the market, they understood the nature of the products they were buying, and they didn't
rely on us for advice," Mr. Switzer said, adding that Scotia Capital was not provided with any information it considered complete or
material. "We continued to rely on the DBRS rating, which did not change, as did others, including, presumably, Canaccord," he said.
The suits are among the first of a potential wave of litigation that could hit the banks and investment dealers if the a co-operative of
investors and banks known as the Crawford Committee (initially known as the Montreal Accord) fails to successfully restructure $33-
billion of stricken ABCP into longer-term investments.
Legal sources said dozens of companies that have been stranded with troubled ABCP, structured by non-bank firms such as Coventree
Inc., are furious that their banks sold them the notes in late July and early August when there were growing signs of turmoil.
These investors have quietly prepared potential lawsuits, but they have put the claims on hold until at least Dec. 14 when the Crawford
Committee is set to unveil its proposals to restructure frozen ABCP.
Jeffrey Carhart, a restructuring specialist with Miller Thomson LLP, said his firm currently represents numerous companies that hold
hundreds of millions of dollars in ABCP. "We really, really, really want the workout process to work, but if it doesn't it stands to reason
that there is going to be litigation," he said.
The B.C. suits against Canaccord were launched by two investors, Gregory Hryhorchuk, the chief financial officer of a gold exploration
company, and First Allied Development Corp., a B.C.-based company owned by Robert Madiuk.
Each suit names Canaccord and one of its salespeople as defendants for putting more than $100,000 of the investor's money into a
third-party ABCP trust called Structured Investment Trust III (SIT III).
The suits allege Canaccord was negligent and breached its duty to the investors for several reasons, including failure to do a reasonable
study of the securities and failure to warn of the purchase risks.
None of the allegations have been proven in court.
In its defence documents, Canaccord says that it did not guarantee the success of any advice it provided and that it was not a custodian
to the investors. If those investors did incur losses, "it was the result of unexpected market occurrences, and not the fault of the
defendant," it states.
It also cites the role of other parties, including credit rating agency DBRS, which gave SIT III commercial paper the highest rating
possible. Canaccord says DBRS failed to take into account that the exposure of SIT III notes to U.S. subprime mortgages could result
in a loss of confidence by the market, and therefore a lack of liquidity.
The rating agency also failed to take into account the limitations of the emergency lines of credit arranged for the trusts, Canaccord
alleges. DBRS has not been named as a party to the lawsuits.
Canaccord also cites Coventree Inc. and its subsidiary Nereus Financial Inc., which created the SIT III trust, for failing to disclose to
Canaccord the trust's actual exposure to U.S. subprime mortgages and for failing to limit the exposure. Neither Nereus nor Coventree
have been named as a party to the lawsuits.
Scotia Capital, the lead dealer for SIT III ABCP, was named as a party.
reportonbusiness.com: Scotia Capital named in ABCP lawsuits Page 1 of 2
http://www.theglobeandmail.com/servlet/ ... alEvents2/ 12/6/2007
It "actively and aggressively marketed [the paper] to Canaccord by means of frequent or daily written and oral solicitations and
communications," Canaccord alleges.
It further alleges Scotia Capital received material information about the trust's exposure to U.S. subprime in July, and acted on that
information.
On July 24, Scotia Capital and other dealers received a Coventree e-mail disclosing some of its trusts' exposures to U.S. subprime
mortgage assets, including SIT III. Canaccord's defence alleges Scotia Capital received the same basic facts from sources before July
14.
"In or about July, 2007, Scotia Capital began to reduce, limit or eliminate its own SIT III ABCP inventory, and the SIT III ABCP
owned by Scotia Capital clients, because of Scotia Capital's knowledge of undisclosed material information concerning the U.S.
subprime exposure of Coventree sponsored ABCP," it alleges.
Between July 10 and Aug. 13, Scotia Capital began offering a higher relative rate of return on the paper, it adds. "Scotia Capital failed
to disclose its knowledge to Canaccord that the rates were higher because Coventree and Nereus conduits, including SIT III, were
experiencing increasing difficulty in finding buyers to purchase new ABCP to fund the payment of maturing ABCP."
It also says Scotia Capital had an ethical standard to resign as a seller of Coventree and Nereus paper after it allegedly received the
material non-public information in July.
CANACCORD CAPITAL (CCI)
Close: unchanged at $15.15
BANK OF NOVA SCOTIA (BNS)
Close: $52.15, down 44¢
http://www.theglobeandmail.com/servlet/ ... alEvents2/ 12/6/2007

Here is today's media on Canaccord adding Scotia Capital as a party to a lawsuit against it by two of its clients concerning Non Bank ABCP. Also, David Dodge spoke out today about the material contracts underlying the ABCP being restricted to DBRS and not accessible to the owners. He is finally calling for new transparency regulation for structured financial products. I have decided that complex structured investment products need to be sold by prospectus with public access to material contracts, even for products only sold to pension funds, governments and corporations.

Plus, New York Attorney General Andrew Cuomo has issued subpoenas for information from three Wall Street firms about their due diligence on securitized products and their relationship with credit rating agencies.

CIBC's stock dropped 5% today upon disclosure of another C$9.3 billion of subprime mortgage exposure through derivatives contracts hedged with unnamed investment-grade counterparties. There is market concern about whether the hedge counterparties will be able to pay their default damage claims. International banks who are counterparties to the credit default swaps in Canada, should be forgiving their claims for default damages from the Non Bank ABCP owners since these material contracts and the limited use liquidity agreements signed by the same banks were not adequately disclosed to the Non Bank ABCP owners and constituted unfair dealing.

Let's hope the vendor group does the right thing and offers make whole settlements to the Non Bank ABCP owners on December 14th.

December 2, 2007
Everybody’s Business
The Long and Short of It at Goldman Sachs

Stuart Goldenberg
By BEN STEIN
FOR decades now, as a writer, economist and scold, I have been receiving letters from thoughtful readers. Many of them have warned me about the dangers of a secret government running the world, organized by the Trilateral Commission, or the Ford Foundation, or the Big Oil companies or, of course, world Jewry.

I always scoff at these letters. The world is far too complex a place to be run by any one group. But the closest I have recently seen to such a world-running body would have to be a certain large investment bank, whose alums are routinely Treasury secretaries, high advisers to presidents, and occasionally a governor or United States senator.

This all started percolating in my fevered brain last week when a frequent correspondent, a gent in Florida who is sure economic disaster lies ahead (and he may be right, but he’s not), forwarded a newsletter from a highly placed economist at Goldman Sachs named Jan Hatzius.

That worthy scholar recently wrote a detailed paper about how he thought the subprime mess would get worse and worse. It would get so bad, he hypothesized, that it would affect aggregate lending extremely adversely and slow down growth.

Dr. Hatzius, who has a Ph.D. in economics from “Oggsford,” as they put it in “The Great Gatsby,” used a combination of theory, data, guesswork, extrapolation and what he recalls as history to reach the point that

when highly leveraged institutions like banks lost money on subprime, they would cut back on lending to keep their capital ratios sound — and this would slow the economy.
This would occur, he said, if the value of the assets that banks hold plunges so steeply that they have to consume their own capital to patch up losses. With those funds used to plug holes, banks’ reserves drop further. To keep reserves in accordance with regulatory requirements, banks then have to rein in lending. What all of this means — or so the argument goes — is that losses in subprime and elsewhere that are taken at banks ultimately boomerang back, in a highly multiplied and negative way, onto our economy.

As the narrator in the rock legend “Spill the Wine” says, “This really blew my mind.”

So I started an e-mail correspondence with Dr. Hatzius, pointing out what I believed were a few flaws in his paper. Among them were his hypothesis that home prices would fall an average of 15 percent nationwide (an event that has never happened since the Depression, although we surely could be headed in that direction), and that this would lead to a drastic increase in defaults and losses by lenders.

This, as I see it, is a conclusion that is an estimation based upon a guess. I found especially puzzling the omission of the highly likely truth that the Fed would step in to replenish financial institutions’ liquidity if necessary. In a crisis like that outlined by the good Dr. Hatzius, the Fed — any postwar Fed except perhaps that of a fool — would pump cash into the system to keep lending on track.

I mentioned this via e-mail to Dr. Hatzius. He generously agreed that there was some slight merit to my arguments and that he was merely pointing out tendencies and possibilities (if I understand him correctly).

BUT forecasting is tricky, and I have a hard time believing that financial events to come will be qualitatively different from those that have already happened.

I do want to emphasize Dr. Hatzius’s gentlemanliness and intelligence. But I also want to emphasize that, as I see it, his document was mostly about selling fear. A spokesman for Goldman Sachs categorically denies this point and says that the firm’s economic research is held to the highest levels of objectivity and that its economists’ views are completely independent.

As I interpret it, Dr. Hatzius was saying that the financial system would possibly not be able to adjust to a level of financial losses that are large on an absolute scale but small compared with aggregate credit or the gross domestic product. He is also postulating that lenders would have to retrench so deeply that lending would stall and growth would falter — an event that, again, has not happened on any scale in the postwar world, except when planned by the central bank.

In other words, with the greatest possible respect to Dr. Hatzius, his paper is not really what I would call a serious overview of the situation. It is more a call to be afraid and cautious based on general principles that he embraces and not on the lessons of history. (In this respect, he is much like many economic journalists and commentators who sell newsprint by selling fear. The common cause of journalists and Wall Streeters in this regard is a subject I will address in the future.)

Now, let me make a few small points here and then get to my own big point.

Goldman Sachs is a huge name in terms of moneymaking and prestige. I totally understand the respect it receives for its financial dexterity. The firm is a superstar in that regard, and I, a small stockholder, am grateful. But it has never been clear to me exactly why its people are considered rocket scientists in any other area than making money.

Dr. Hatzius’s paper is a prime example of my puzzlement. It shows extreme intelligence but basically misses the point: yes, there are possible macro dangers, but you have to go all the way around Robin Hood’s barn to get to them, and you have to use what I think are extremely far-fetched hypotheticals to get to a scary situation. (This is not to diminish the real risks in today’s economy, I’m just not as gloomy about them as Dr. Hatzius.)

Why, then, is his document circulating? Perhaps as a token of Dr. Hatzius’s genuine intelligence, which is fine. But to me, his paper seemed like a selling document in the real Wall Street sense of selling — namely, selling short. (Dr. Hatzius notes that he has long been bearish on housing, since faraway 2006, but I respectfully note that that is a lot different from predicting a credit catastrophe. The spokesman for Goldman also noted the company’s bearishness on housing since 2006. He also noted that in the recent past, Goldman Sachs has moved to a considerably larger short posture and that the firm is net short.)

More thoughts came to me as I read a recent piece in Fortune by my colleague Allan Sloan, a veteran financial writer. Mr. Sloan traces the life and death throes of a Goldman Sachs-arranged collateralized mortgage obligation. He shows how truly toxic waste was sold to overly eager investors who now have major charge-offs, and he also points out that some parts of the C.M.O. were indeed safe and were either current or had been paid off.

But what leaps out at me from this story is that Goldman Sachs was injecting dangerous financial products into the world’s commercial bloodstream for years.

My pal, colleague and alter ego, the financial manager Phil DeMuth, culled data from a financial Web site, ABAlert.com (for “asset-backed alert”), that Goldman Sachs was one of the top 10 sellers of C.M.O.’s for the last two and a half years. From the evidence I see, Goldman was doing this for years. It might have sold very roughly $100 billion of the stuff in that period, according to ABAlert. Goldman was doing it on a scale of billions even when Henry M. Paulson Jr., the current Treasury secretary, led the firm.

The Goldman spokesman would not comment on this except to note that other firms sold C.M.O.’s too.

The point to bear in mind, as Mr. Sloan brilliantly makes clear, is that as Goldman was peddling C.M.O.’s, it was also shorting the junk on a titanic scale through index sales — showing, at least to me, how horrible a product it believed it was selling.

The Goldman Sachs spokesman said that the company routinely shorts the securities it underwrites and said that this is disclosed. He noted candidly that Goldman is much more short in this sector than usual.

Here is my humble hypothesis, even after talking to Goldman: Is it possible that Dr. Hatzius’s paper was a device to help along the goal of success at bearish trades in this sector and in the market generally? His firm says his paper, like all of its economists’ work, was not written to support any larger short-trading strategy. But economists, like accountants, are artists. They have a tendency to paint what their patrons, who pay them, want to see.

From what I have observed over the years, Goldman has a fascinating culture. It is sort of like what I imagine the culture of the K.G.B. to be. You always put the firm first. The long-ago scandal of the Goldman Sachs Trading Corporation, which raised hundreds of millions just before the crash of 1929 to create a mutual fund, then used the fund’s money to prop up stocks it owned and underwrote, was a particularly sad example. The fund, of course, went bust.

Now, obviously, Goldman Sachs does many fine deals and has many smart, capable people working for it. But it’s not the Vatican. It exists to make money for the partners and (much farther down the line) the stockholders. The people there are not statesmen. They are salesmen.

To my old eyes, the recent unhappiness about mortgages and Goldman’s connection with them are not examples of sterling conduct. It is bad enough to have been selling this stuff. It is far worse when the sellers were, in effect, simultaneously shorting the stuff they were selling, or making similar bets.

Doesn’t this bear some slight resemblance to Merrill selling tech stocks during the bubble while its analyst Henry Blodget was reportedly telling his friends what garbage they were? How different would it be from selling short the junky stock that your firm is underwriting? And if a top economist at Goldman Sachs was saying housing was in trouble, why did Goldman continue to underwrite junk mortgage issues into the market?

HERE is a query, as we used to say in law school:

Should Henry M. Paulson Jr., who formerly ran a firm that engaged in this kind of conduct, be serving as Treasury secretary?
Should there not be some inquiry into what the invisible government of Goldman (and the rest of Wall Street) did to create this disaster, which has caught up with some Wall Street firms but not the nimble Goldman?
When the Depression got under way, the government created the Temporary National Economic Committee to study just what had happened on the Street to get the tragedy going. Maybe it’s time for an investigation of just what Wall Street and Goldman did to make money as they pumped this mortgage mess into the economic system, and sometimes were seemingly on both sides of the deal.

Or is Goldman Sachs like “Love Story”? Does working there mean never having to say you’re sorry?

By JENNY ANDERSON and VIKAS BAJAJ
As the subprime loan crisis deepens, Wall Street firms are increasingly coming under scrutiny for their role in selling risky mortgage-related securities to investors.

Many of the home loans tied to these investments quickly defaulted, resulting in billions of dollars of losses for investors. At the same time, many of the companies that sold these securities, concerned about a looming meltdown in the housing market, protected themselves from losses.

One big bank that saw the trouble coming, Goldman Sachs, began reducing its inventory of mortgages and mortgage securities late last year. Even so, Goldman went on to package and sell more than $6 billion of new securities backed by subprime mortgages during the first nine months of this year.

Of the loans backing the Goldman deals for which data is available, nearly 15 percent are already delinquent by more than 60 days, are in foreclosure or have resulted in the repossession of a home, according to data compiled by Bloomberg. The average default rate for subprime loans packaged in 2007 is 11 percent.

“There is a maxim that comes to mind: ‘If you work in the kitchen, you don’t eat the food,’” said Josh Rosner, a managing director of Graham Fisher, an independent consulting firm in New York.

The New York attorney general, Andrew M. Cuomo, has subpoenaed major Wall Street banks, including Deutsche Bank, Merrill Lynch and Morgan Stanley, seeking information about the packaging and selling of subprime mortgages. And the Securities and Exchange Commission is examining how Wall Street companies valued their own holdings of these complex investments.

The Wall Street banks that foresaw problems say they hedged their mortgage positions as part of their fiduciary duty to shareholders. Indeed, some other companies, particularly Citigroup, Merrill Lynch and UBS, apparently did not foresee the housing market collapse and lost billions of dollars, leading to forced resignations of their chief executives.

In any case, the bankers argue, buyers of such securities — institutional investors like pension funds, banks and hedge funds — are sophisticated and understand the risks.

Wall Street officials maintain that the system worked as it was supposed to. Underwriters, they say, did not pressure colleagues on trading desks or in research departments to promote securities blindly.

Nevertheless, the loans that many banks packaged are proving to be increasingly toxic. Almost a quarter of the subprime loans that were transformed into securities by Deutsche Bank, Barclays and Morgan Stanley last year are already in default, according to Bloomberg. About a fifth of the loans backing securities underwritten by Merrill Lynch are in trouble.

Data from another firm that tracks mortgage securities, Lewtan Technologies, shows similar trends. The banks declined to comment on the default rates.

The data raises questions about how closely Wall Street banks scrutinized these loans, many of them made at low teaser rates that will reset next year to higher levels.

The Bush administration is close to a plan to freeze mortgage rates temporarily for some homeowners who are threatened with foreclosure.

In recent years, Wall Street aggressively pushed into the complex, high-margin business of packaging mortgages. At the same time, banks expanded their roles to selling investments to clients while trying to make money on their own holdings. Now, with the collapse of the credit bubble, Wall Street’s risk management, as well as the multiple and often conflicting roles it plays, has been laid bare.

As early as January 2006, Greg Lippmann, Deutsche Bank’s global head of trading for asset-backed securities and collateralized debt obligations, and his team began advising hedge funds and other institutional investors to protect themselves from a coming decline in the housing market.

“He was really pounding the pavement,” said one hedge fund trader, who asked not to be identified because it could jeopardize his relationship with Wall Street banks.

Mr. Lippmann’s trade ideas — documented in a January 2006 presentation obtained by The New York Times — were not always popular inside Deutsche Bank, where the origination desk was busy selling mortgage securities. In the fall of 2006, Mr. Lippmann pitched bearish trades to the bank’s sales force at the same time the origination desk was bringing them mortgage deals to sell to clients.

Last year, Deutsche Bank underwrote $28.6 billion of subprime mortgage securities, according to Inside Mortgage Finance, an industry publication. In the first nine months of this year, the bank underwrote $12 billion.

Goldman Sachs also moved early to insulate itself from potential losses. Almost a year ago, on Dec. 14, 2006, David A. Viniar, Goldman’s chief financial officer, called a “mortgage risk” meeting. The investment bank’s mortgage desk was losing money, and Mr. Viniar, with various officials, reviewed every position in the bank’s portfolio.

The bank decided to reduce its stockpile of mortgages and mortgage-related securities and to buy expensive insurance as protection against further losses, said a person briefed on the meeting who was not authorized to speak about the situation publicly.

Goldman, however, did not stop selling subprime mortgage securities. The bank, like other firms, retains a piece of the securities it sells. A Goldman spokesman said the firm was not betting against the mortgage securities it underwrote in 2007.

Like Goldman, Lehman Brothers also started to hedge its huge inventory of home loans in the second quarter of this year, concerned about poor underwriting standards. But Lehman also continued to sell mortgage securities packed with shaky loans, underwriting $16.5 billion of new securities in the first nine months of 2007. About 15 percent of the loans backing these securities have defaulted.

At the center of the boom in mortgages for borrowers with weak credit was Wall Street’s once-lucrative partnership with subprime lenders. This relationship was a driving force behind the soaring home prices and the spread of exotic loans that are now defaulting in growing numbers. By buying and packaging mortgages, Wall Street enabled the lenders to extend credit even as the dangers grew in the housing market.

“There was fierce competition for these loans,” said Ronald F. Greenspan, a senior managing director at FTI Consulting, which has worked on the bankruptcies of many mortgage lenders. “They were a major source of revenues and perceived profits for both the originators and investment banks.”

The battle over these loans intensified in 2005 and 2006, as home prices approached their zenith. (Home sales peaked in mid-2005.) At the same time, buyers of these securities, which carry relatively high interest rates, were fueling demand. Lehman Brothers, the dominant Wall Street player in this field, underwrote $51.8 billion of subprime mortgage securities in 2006, followed by RBS Greenwich Capital, which arranged $47.6 billion of sales.

Not all banks continued to expand their subprime business. Credit Suisse, which had been a major player in 2005, pulled back aggressively, with its underwriting down 22 percent in 2006, compared with 2004.

But other Wall Street banks, pushing to catch these market leaders, reached out to subprime lenders. Morgan Stanley, which expanded its subprime underwriting business by 25 percent from 2004 to 2006, cultivated a relationship with New Century Financial, one of the largest subprime lenders. The firm agreed to pay above-market prices for loans in return for a steady supply of mortgages, according to a former New Century executive.

“Morgan would be aggressive and say, ‘We want to lock you in for $2 billion a month,’” said the executive, who asked not to be identified because he still works with Wall Street banks.

Loans made by New Century, which filed for bankruptcy protection in March, have some of the highest default rates in the industry — almost twice those of competitors like Wells Fargo and Ameriquest, according to data from Moody’s Investors Service.

Fremont General and ResMae, which also had high default rates, were big suppliers of loans to Deutsche Bank. Merrill Lynch had a close relationship with Ownit Mortgage Solutions, which filed for bankruptcy in December. Merrill also acquired another lender, First Franklin, for $1.7 billion in late 2006.

“The easiest way to grab market share was by paying more than your competitors,” said Jeffrey Kirsch, president of American Residential Equities, which buys home loans.

What is clear is that home loans were highly lucrative to Wall Street and its bankers. The average total compensation for managing directors in the mortgage divisions of investment banks was $2.52 million in 2006, compared with $1.75 million for managing directors in other areas, according to Johnson Associates, a compensation consulting firm. This year, mortgage officials will probably earn $1.01 million, while other managing directors are expected to earn $1.75 million.

Is it greed? Stupidity? Or simply the new Golden Rule in this era of financial corruption: "Do it to others, before they do it to you."

Fallout from questionable investments called Asset Backed Commercial Paper (ABCPs) is hitting everywhere in Canada -- and if Bay Street forensic accountant Al Rosen is right, this is just the tip of the iceberg.

Companies, pension plans, governments, small investors and even taxpayers are victims as these controversial debt instruments sink like the Titanic after sparking a liquidity crisis and market meltdown this past summer.

The latest fallout is the first loss in 15 years for National Bank, Canada's sixth largest bank, which yesterday reported it lost $175 million, or $1.14 a share, in the fourth quarter. Overall, National's 2007 profit was $541 million, down from a $871-million profit in 2006. But if it hadn't invested in ABCPs, its profit would have been $933 million.

Earlier this week, Bank of Montreal announced a 35% drop in its fourth-quarter profit to $452 million, down from $696 million a year ago.

Expect more bad news as the bank profit parade continues.

So far, only Toronto-Dominion Bank -- smart enough to steer away from ABCPs -- has been left unscathed, yesterday reporting a 44% jump in fourth-quarter profit, earning a whopping $1.09 billion.

But getting hit is not just banks -- whose brokerages, I'm sure, made sweet commissions selling these questionable investments.

In the Yukon, Ottawa's auditor general has been called in to investigate how the territory became exposed to $36.5 million in ABCPs. Buying these babies may have violated a federal act governing territorial government investments.

In Quebec, the head of Caisse de depot et placement, who manages Quebec's public pension fund, has been hauled onto the red carpet to explain how it became exposed to $13.2 billion in ABCPs.

The City of Hamilton -- already facing financial hardship -- is also taking a hit with a $97-million exposure in its $691-million investment fund. The city will announce a restructuring plan for its security holdings on Dec. 14.

But, so far, there's not a peep of a probe at Queen's Park, where there's also exposure to this mess, tied to the U.S. subprime crisis. Ontario Financing Authority was exposed by $700 million, Ontario Power Generation by $103 million though it's sold some of its ABCPs, and the Ontario Teachers Pension Plan by $60 million.

The Greater Toronto Airport Authority was exposed by $249 million.

Like Premier Dalton McGuinty's take on Ontario's faltering economy, the line on Bay Street is "don't worry, be happy." After all, the babies came with an R-1 credit rating from Dominion Bond Rating Service, the highest rating commercial paper can score.

But Rosen says the R-1 rating really can be a rating of lousy. "People didn't know the quality of the assets that was backing the paper, and now the losses are going to be fairly high in some situations," said Rosen, a principal with Rosen & Associates in Toronto.

Meanwhile, an investors committee headed by Purdy Crawford hopes to find a solution to the non-bank ABCP madness.

The subprime mortgage and asset-backed paper scandals constitute one of the biggest frauds ever perpetrated. They have resulted in mass foreclosures, writedowns, bankruptcies, firings and billions lost. The US$10-trillion U.S. home-lending sector was, and perhaps still is, rotten. At the top were mortgage lenders, then Wall Street and others who exported junk debts to lenders around the world after prettying them up.

At the bottom was a corrupt system that handed out mortgage broker licences like driver's licences, and then handed out mortgages like candy at Halloween. In between were crooked appraisers and organized crime.

The stories are now seeping out. A money manager friend of mine said his limousine driver in Chicago became a mortgage broker then made a fortune indiscriminately handing out mortgages to friends and relatives. He retired to Poland a multi-millionaire. In Cleveland, a church preacher moonlighted as a broker and put his parishioners into houses they could not afford, including a 78-year-old woman just kicked out of her home.

Miami police have uncovered a massive foreclosure fraud scheme involving appraisers, brokers and accountants who recruited straw buyers, inflated condo prices, drew up fake tax returns, got huge mortgages, paid developers less than the mortgage raised and pocketed the difference. The straw buyer was paid off and abandoned the property to foreclosure.

The press thinks this is a financial story. It's a police story. These scandals contain all the necessary elements that characterize all world-class frauds: 1. Many "little" people must be involved who don't know what others are up to or that they are party to a crime. That makes proving conspiracies and criminal intent difficult. 2. As many borders as possible must be put in place between the victims and the perpetrators. That makes investigation expensive or impossible. 3. Perpetrators should not be in the same country as victims. If victims are foreign, police investigations are less politically justifiable.

These three elements provide the "winning conditions" for every successful fraud because far-flung wrongdoing, involving many jurisdictions, frustrates the press, the law enforcement officials and makes litigation expensive or even impossible.

Offshore manoeuvres, like Enron or Bre-X's, allowed the frauds to grow undetected, giving the bad guys time to get away or to hide their ill-gotten gains. Some have had time enough to end up on a beach somewhere that doesn't have any extradition treaties.

This is why the RCMP did not "get their man" in the $9-billion Bre-X fraud. The case was too complicated and expensive to pursue and too many victims and the perpetrators were outside of Canada. Enron, by contrast, was heatedly pursued because the victims and the perpetrators were in the United States, plus there were links to the George Bush Presidency.

In the subprime mess, there seems little political will to do much of anything south of the border. Foreclosures dot the urban landscape, mostly affecting speculators or disenfranchised people. Wall Streeters get tossed from jobs, write down fortunes and collect obscene severance. It's all business and usual. I hope intermediaries will be sued out of existence by the deep pockets they damaged and defrauded.

yes, the commercial asset backed crisis is indeed another example of a knowingly tainted investment product.

designed to deliver risks of failure to trusting customers of investment dealers, while delivering massive commissions to the middlemen, this video will explain pretty much everything the layman will need or want to know about the Asset backed commercial paper crisis

National Post - Think tank slams asset-backed market, October 12, 2007, says:
"The top international banking think-tank has slammed banks and regulators in Canada and elsewhere for the way they allowed the market for asset-backed securities to dry up earlier this year.

"The industry has to recognize that we were at fault big time," said Philip Suttle, a director at the Institute for International Finance, a lobby group for more than 360 of the world's major banks, including the five biggest in Canada.

"A lot of us were asleep at the switch, both regulators and market participants," said Mr. Suttle, who was speaking in an interview after the IIF submitted a letter expressing its concerns about the market to the International Monetary and Finance Committee -- a committee of the IMF that meets next week in Washington."

"...the IIF noted that the Canadian market in particular was "different because the back-up facilities that the securities had in the Canadian market were less complete than [elsewhere.]"

"The IIF's letter also takes a straight shot at the credit rating agencies that put a rating on asset backed securities.

"The sudden multi-notch downgrading and large price declines of some structured products that initially received high investment grade ratings have raised questions as the appropriateness of the methodology used to assign ratings to structured products," the letter states."

"The letter warns against an over reaction to the market turmoil in the form of too much regulation, and also calls for banks to develop better disclosure rules on asset-backed securities and an improved method of valuing the securities."

My conclusions about this report on the Institute for International Finance's letter to the International Monetary and Finance Committee:

(1) the pension beneficiaries, taxpayers and shareowners of Canada that pay the costs for damages from the frozen Third Party ABCP must be made whole, regardless of whether the buyers were accredited investors or not.

The damages, equal to the difference between the market values, when the frozen paper becomes restructured and traded in the open market, and the original face amount of the frozen paper, must be paid for by the Canadian Third Party ABCP conduit sponsors; the international and Canadian bank signatories to the defective Canadian liquidity agreements ; any additional Canadian investment bank distributors of the Third Party ABCP; and, DBRS.

(2) OSFI must immediately remove its OSFI Regulation B-5, so that liquidity agreements backing any Canadian-based investment product sold to both retail or accredited investors are not permitted to be of "limited to no use". The capital differential of 0% for the Made-in-Canada "limited to no use" liquidity agreement and 10% for the international standard 100% guaranteed liquidity agreement must be eliminated so that Canada's federal bank regulator is not providing an incentive for banks to skim fees for "limited to no use" liquidity agreements and is not giving the commercial paper vendor group the opportunity to deceive buyers who trusted that the securities they bought had sound liquidity agreements, were top rated and safe.

Transparency is not a sufficient solution. There should be no opportunity to sell investment products with "limited to no use" liquidity agreements since this enables banks to skim fees from Canadian investors for which there is no beneficial service provided.

OSFI B-5 Regulation says:

"Liquidity support is a commitment to lend to, or purchase assets of, an SPE in order to provide investors with assurance of timely payment of principal and interest. Liquidity support may include a general market disruption clause. A general market disruption can be defined as a disruption in the Canadian commercial paper market resulting in the inability of Canadian commercial paper issuers, including the SPE, to issue any commercial paper, and where the inability does not result from a diminution in the creditworthiness of the SPE or any originator or from a deterioration in the performance of the assets of the SPE."

(3) The Federal Parliament, through the Federal Minister of Finance, should appoint a qualified independent monitor to ensure that the interests of the pension beneficiaries, taxpayers and shareowners are being met in the decisions of the Montreal Accord Group and Pan Canadian Committee.

(4) The House of Commons Finance Committee must hold hearings on the lessons learned from the Canadian Third Party ABCP fiasco and the general malfunctioning of Canada's securities regulation and white collar crime enforcement system. The hoped for outcome of this hearing would be a new Federal Government securities law and a national securities commission. The existing investment industry SRO's and provincial securities commissions have failed to protect Canadians once again. Average Canadians can no longer afford to take more billions of dollar damages from Made-In-Canada defective investment products and white collar securities crime.

(5) Canada's top priority, however, is to develop a properly functioning independent RCMP white collar crime police unit, that has the confidence of international police forces and collaborates with municipal and provincial police forces throughout Canada. The RCMP must discontinue its reliance on referrals for criminal investigations from the investment industry SRO's and the provincial securities commissions.

Canadian banks are struggling to contain a credit crisis that could spiral out of control here more than it has elsewhere because of a lax regulatory regime, sources have told the National Post.

The crisis relates to the market for a complex type of short-term funding known as asset backed commercial paper (ABCP), which had grown out of proportion in this country partly thanks to Canadian rules that were not as tough as in other nations.

"It's a made-in-Canada problem," said Claude Lamoureux, head of Ontario Teachers' Pension Plan. Many people in the market "didn't know or didn't ask questions" because they were making more profits than elsewhere, he added.

The Canadian ABCP market attracted a flood of foreign financial institutions such as Barclays Bank and Deutsche Bank, who exploited the gaps in the Canadian ABCP rules to make big profits at lower risk to themselves, sources said.

"They were effectively able to earn fees from supplying liquidity without ever having to supply the liquidity or set aside capital," said a source.

In the worst-case scenario, if global financial players lose confidence in the Canadian ABCP system altogether, the crisis could spread to Canada's big banks, leaving them on the hook for tens of billions of dollars.

ABCP is a package of debt obligations -- anything from car loans to credit-card debt. The product grew in popularity in recent years among everyone from pension funds to corporate treasury departments to banks because ABCP offered higher returns than, for example, a corporate bond or treasury bill.

Typically, ABCP products also involve liquidity support from a supplier, usually a major bank. In simple terms it is an agreement to buy the ABCP in the event of a disruption to the market.

In Canada, the market grew more quickly than in other countries, doubling between 2000 and 2007 to $120-billion, because the Canadian definition of disruption to the market was much narrower than elsewhere.

In Canada, liquidity suppliers did not have to provide funding except in catastrophic circumstances.

Also the Canadian banking regulator, unlike regulators in other countries, did not ask the liquidity supplier -- the bank -- to set aside any capital, so they could use it to grow other lines of business.

In addition, Canadian debt rating agency Dominion Bond Rating Service gave a rating to Canadian ABCP even though other rating agencies such as Moody's and Standard & Poors shied away from doing so.

By June this year, Canada's ABCP market was about 10% of the size of the market in the United States, although the overall U.S. financial system is proportionately far larger than Canada's.

When concerns surfaced in August about the underlying assets in ABCP -- many of which have included troubled mortgage loans in the U.S. -- some owners of ABCP were caught off guard. Owners of ABCP were under the belief that they could convert it to cash or another similar product at the end of 30 or 60 days but instead were left holding the product.

Canadian investment bank Coventree Capital Inc. became one of the first major victims of the global credit crunch when it was unable to trade the ABCP it was holding because of the general seizing up of credit markets around the world.

Following Coventree's collapse, Canadian non-bank owners of $40-billion of troubled asset-backed commercial paper -- pension funds and corporate treasury departments -- were forced into an unprecedented joining-of-forces known as the Mont-real Accord to try to salvage their holdings.

If the Montreal Accord does not result in a long-term agreement on how to resolve the issues in Canada's non-bank ABCP market by an Oct. 15 deadline, there could be a carryover effect on the demand generally for ABCP, said Blackmont's Mr. Smith.

"Failure to fully restore investor confidence levels could reduce demand ...which could restrict the future ability of banks to manage capital," he said.

Mr. Smith calculated that Canada's big six banks are on the hook for total liquidity facilities worth $135-billion.

Canada's bank regulator -- the Office of the Superintendent of Financial Institutions -- did not return calls from the National Post seeking comment for this story. However, in an e-mail the regulator indicated that the rules enforced in Canada were in accordance with international guidelines.

HOW IT WORKS

▌A bank packages a collection of mortgages, credit card balances, or lines of credit into an ABCP that matures in 30 days.

▌The bank sells ABCP for a fee to an intermediary that assumes all the risk associated with the underlying assets.

▌The intermediary sells pieces of the ABCP to investors, including pension funds or corporations or individuals.

▌Investors are paid interest and assume there will be a buyer for their piece of the ABCP after 30 days.

▌For a fee, the bank supplies funds to buy the ABCP if there are no other buyers

▌in Canada, this feature did not work in August when investors could not find a buyer.

Another Made-in-Canada Defective Investment Product
Pensioners, Taxpayers and Shareowners Bear Loss on Defective Commercial Paper
Prepared By: Diane Urquhart, Independent Analyst
Updated October 2, 2007
Summary
$4 billion to $20 billion is the expected loss on another Made-In-Canada defective
investment product - Third Party Asset Backed Commercial Paper (Third Party ABCP).
Pension beneficiaries, taxpayers and shareowners will bear this loss on the defective
commercial paper held by government and corporation pension funds and treasuries.
The $40 billion Third Party ABCP is a Made-in-Canada defective investment product,
mainly because it has Made-in-Canada liquidity agreements. Canadian liquidity
agreements were below international standard and contained provisions that allowed
banks to walk away from calls for cash to repay the Canadian Third Party ABCP owners,
who wanted their cash back on the maturity date, usually 30 to 90 days after purchase.
Dominion Bond Rating Services (DBRS) bears significant responsibility for giving false
top credit ratings on the ABCP that did not meet the international standard for liquidity
agreements, nor any of the other five basic investment axioms listed in this report. Other
international credit rating firms, and especially Standard & Poors Canada, would not rate
the Canadian paper, let alone give it a top credit rating. On September 12, 2007, DBRS
announced it was moving to the international standard for liquidity agreements.
The Federal Office of the Superintendent of Financial Institutions (OSFI) Regulation B-5
permitted the banks to sign what I call the "Made-in-Canada" defective liquidity
agreements for the Third Party ABCP. The banks did not need to assign capital for their
obligations under the Canadian standard liquidity agreements, because these liquidity
agreements were of no use and would almost never lead to bank back-up payments to the
ABCP owners. As such, OSFI has assisted the banks to skim fees from the ABCP
conduits, which reduced the interest paid to the retail investors, Canadian pension funds
and corporations owning ABCP.
The Third Party ABCP market effectively froze in August 2007, when Canadian
investors were no longer willing to buy the CP, due to their increased awareness of its
potential for loss. If banks walking away from liquidity agreements was not enough of a
problem, there is widespread ownership of credit default swaps within the conduits,
where counterparties have the right to make margin calls for more cash to be added to the
conduits, and to lay claim to the collateral of quality assets in the conduit. The owners of
the Third Party ABCP would naturally have assumed that the quality assets in the conduit
were exclusive collateral to their own loans to the conduit. Credit default swaps are not
covered in the Canadian Companies' Creditor Arrangement Act, so the restructuring
proposals are not subject to court management.
2
The rights of the banks in the credit default swaps to call margin and to claim collateral
refutes the hope of no losses on the Third Party ABCP in both the short and the long term
for the group of conduits, as a whole. The banks that are counterparties to the credit
default swaps are the same banks who signed the defective liquidity agreements in most
of the problem conduits. These bank put themselves into the powerful position of being
able to make a call for cash to pay for default damages under their swap, knowing that
they would walk from their liquidity agreements and gain access to the
conduit's collateral of top rated assets held in trust. These bank counterparties had the
control to trigger the crisis for the Third Party ABCP owners in Canada.
This time it is the investment banks' preferred government and corporation customers that
are losing money on what they understood to be a very low risk place to park cash. Retail
investors, still reeling from the capital losses caused by financial reporting deceptions in
income trusts, are largely spared from the pending damages in Third Party ACPB, as this
is not a retail product.
Canadian beneficiaries of pension plans and the shareowners of crown corporations and
corporations bear the loss from the defective Third Party ABCP. The professional money
managers buying the defective paper were negligent in their due diligence, or they were
deceived by the Third Party ABCP sponsors, bank credit default swap counterparties and
liquidity agreement signatories, investment bank distributors and/or DBRS.
There were substantial risk premium dollars within the Third Party ABCP structures to
cover the liquidity, default and leverage risks. However, the Third Party ABCP sponsors,
bank credit default swap counterparties and liquidity agreement signatories and
investment bank distributors took most of the risk premium for themselves in fees and
profits, while the owners of the Third Party ABCP only got 5 to 10 basis points. The
vendor group took most of the risk premium, even though they must have known they
shifted all of the risk to the owners through limited use liquidation agreements and credit
default swaps making owners pay for leveraged default damages.
The Montreal Accord Group and Purdy Crawford's Pan Canadian Committee of Investors
in Third Party ABCP cannot make the pension funds, crown corporation and private
sector corporation treasuries whole. The members of the Montreal Accord Group are
primarily the banks/investment banks who are the credit default swap counterparties,
liquidity agreements signatories or distributors of the defective investment product. The
members of the Pan Canadian Committee include senior management of the government
pension funds and crown corporation treasuries who bought the defective paper. There is
one corporation owner represented on the Group or Committee.
Both the Montreal Accord Group and the Pan Canadian Committee are highly motivated
for a quick and opaque solution, since they are vendors, who were either negligent or
intended to deceive the buyers; or, they are professional buyers, who were either
negligent, or deceived by the vendor group.
3
The Federal Parliament, through the Federal Minister of Finance, must appoint a
qualified independent monitor to ensure that the interests of the pension
beneficiaries, taxpayers and shareowners are met. It is not suffice that Purdy
Crawford will be guided by his own views as to fairness, since he is employed by the Pan
Canadian Committee, whose members are more concerned about their personal
reputations and jobs than the loss to be borne by the pension beneficiaries, taxpayers and
shareowners.
Third Party ABCP is another Made-in-Canada defective investment product that
demonstrates there is no investor protection for investors and pensioners in Canada.
Craig Hannaford and Bill Majher, former RCMP white collar crime investigators,
say in Canadian Business on September 24, 2007, "The system is pretty much nonexistent."
No one stops defective investment products in Canada; no one answers
911 calls from Canadians suffering losses on defective investment products; and
those responsible for the defects are allowed to create closed shop restructuring
solutions at the expense of average Canadians.
Another Made-in-Canada Defective Investment Product................................................... 1
Pensioners, Taxpayers and Shareowners Bear Loss on Defective Commercial Paper....... 1
Summary ............................................................................................................................. 1
Investment Axioms Not Followed in Canada's Third Party ABCP.................................... 4
Banks Have Different Treatments for Different ABCP Owners ........................................ 5
Who are the Vendors of Third Party ABCP?...................................................................... 6
Who Bears the Loss From Made-in-Canada Defective Commercial Paper? ..................... 8
The Workout Process........................................................................................................ 10
Not a Controllable Situation Since Credit Default Swaps Not Covered By the
Companies' Creditor Arrangement Act............................................................................. 11
Office of Superintendent of Financial Institutions Permitted Defective Liquidity
Agreements ....................................................................................................................... 13
The Pan Canadian Committee Cannot Make the Pension Beneficiaries, Taxpayers and
Shareowners Whole .......................................................................................................... 15
Urgent Changes Needed in the Workout Process ............................................................. 16
A Final Word on Where Are the Securities Regulators?.................................................. 18
4
Investment Axioms Not Followed in Canada's Third Party ABCP
1. ABCP bank liquidity agreements cannot have general ABCP market disruption or
diminished asset creditworthiness loopholes, if liquidity risk and default risk is to
be eliminated. This is the international standard for liquidity agreements, before
ABCP receives a top investment rating from international credit rating agencies.
2. Funding long term assets with short term commercial paper causes high liquidity
risk.
3. ABCP owning sub prime mortgages has default risk since sub prime mortgage
borrowers having a high probability of not being able to meet their interest
payments.
4. ABCP containing derivatives, that are untested in different economic
environments, is risky. Derivatives not used for hedging do not belong in
commercial paper, that owners regard to be almost risk free.
5. Not knowing how the investment product vendors share the investment returns
and risks usually puts you at the short end of the bargain. Credit default swaps
are said by insiders to have been added to the ABCP to boost the yields above the
no risk return of T-bills. But, the conduit owners and bank suppliers and
distributors took the lion's share of the boosted yield, even though they knew the
owners were ultimately responsible for all of the liquidity and default losses, and
not them.
a) In a credit default swap, the seller is obliged to pay for the default losses
on credit he does not own. The buyer of the credit default swap pays
premiums to the seller, which the seller uses to fund his future obligation
to pay for credit losses. But these premiums prove to be insufficient if the
default damages are higher than expected. Consequently, the marked to
market valuations of credit default swaps can be volatile, even when the
risk of default at the levels defined in the contract seem remote at the time
the contract was entered into. Credit default swap counterparties have
right to call for additional margin and to lay claims to collateral.
b) Even if there is just 5 to 10 basis points higher return over risk free
alternatives, ask questions about the risk and what's in it for the vendors.
6. Adding leverage to boost investment returns always adds risk, when conditions
deteriorate. In the ABCP, the credit default swaps were in dollar amounts that
were 10 to 20 times more than the amount invested in the ABCP, so that even a
modest adverse change in marked to market credit default swap prices leads to
serious % capital loss on the ABCP investment.
5
Banks Have Different Treatments for Different ABCP Owners
Figure 1 shows that Canada's total money market is $360 billion, of which 32% is risk
free government treasury bills. The ABCP component of the money market is 32% or
$115 billion. ABCP has two types: Bank ABCP and Third Party ABCP. Bank ABCP is
issued by conduits manufactured and distributed by the major banks or their wholly
owned investment banks. Third Party ABCP, on the other hand, is issued by conduits
manufactured by the 5 non bank financial corporations named in Figure 2. The Third
Party sponsored conduits were distributed by the major investment banks to Canada's
investing clients. It was the $40 billion Third Party ABCP that effectively froze in
August 2007, when owners of the Third Party ABCP asked for their money back and the
foreign banks who were the signatories to the liquidity agreements backing this paper
refused a call for funds because conditions for the call were not met.
On August 20, 2007, four days after signing the Montreal Accord, the National Bank of
Canada announced it is acquiring $1.85 billion of Third Party ABCP, held in National
Bank and affiliate mutual funds, pooled funds or direct brokerage accounts of its retail
clients and of any corporations clients, who hold $2 million or less of ABCP in their
accounts, and who do not qualify as accredited investors under securities regulations.
Government and corporation pension funds and treasuries fall under the definition of
accredited investors under provincial securities laws, so these are not being reimbursed
by National Bank for expected damages.
The other major banks have announced their intent to guarantee the buyback of their own
Bank ABCP. These other major banks have also volunteered to indemnify losses for
Third Party ABCP held in their own mutual funds. However, retail brokerage clients who
purchased Third Party ABCP directly or in trust securities, like the Global Diversified
Investment Grade Trusts I and II, have not received voluntary offers to cover their
damages. The government and corporation pension funds and treasuries, that are
accredited investors, who bought the Third Party ABCP from the institutional money
market desks will also not be compensated by the other major banks.
Banks volunteering compensation to the retail mutual fund owners is likely due to their
conflicts of interest in making fees from both distributing the Third Party ABCP and from
management of the mutual fund. The bank owned mutual fund portfolio managers have a
duty to select securities that maximize performance in the interest of the mutual fund
unitholders. Retail brokerage clients purchasing Third Party ABCP directly are owed a
duty of care by their financial advisors, and so a case can be made for them to also
receive voluntary compensation.
The sophisticated institutional and corporation clients, who bought Third Party ABCP,
are expected to do their own homework and not to trust their investment bank or credit
rating agencies, when Third Party ABCP is marketed to be top investment grade and safe.
The sophisticated institutional and corporation clients can only expect successful
litigation and restitution, if there is misrepresentation or fraud in the information
memorandum or credit rating, or there is negligence on the part of the sponsors,
investment banks, or DBRS.
6
Figure 1: Canada's Money Market ByType of Security
Who are the Vendors of Third Party ABCP?
Figure 2 summarizes names from the Information Memorandum for the 23 problem
conduits at http://research.cibcwm.com/commercialpa ... cp_i.shtml . The
sponsors of the Third Party ABCP conduits are: Coventree Capital Group, Dundee
Securities, Metcalfe & Mansfield Alternative Investments, Nereus Financial (a wholly
owned subsidiary of Coventree Capital Group), Newshore Financial Services and
Securitus Capital. The original distribution agents shown in Figure 2 are BMO, CIBC
World Markets, Desjardins Bank Securities, Deutsche Bank Securities, HSBC Securities,
Laurentian Bank Securities, National Bank of Canada, RBC Dominion, Scotia Capital
and Société Générale Securities. The underlined distribution agents are not on the
Montreal Accord Group and Pan Canadian Committee.
Every investment bank operating an institutional money market desk would have been
executing trades in the 23 problem conduits with their pension fund, corporation and
government clients.
There were just three legal firms who provided the legal services to the 23 problem
conduits: Davies, Ward Phillips & Vineberg, McCarthy Tetrault and Ogilvie Renault.
7
Figure 2: Third Party ABCP Sponsors & Distributors
Trust Names Securitization Agents
Liquidity Agreements/
Credit Default Swaps Distribution Agents Legal Counsel
Information Memorandum
Coventry Capital Group Inc.
Dundee Securities
Metcalfe & Mansfield Alternative Inv
Nereus Financial Inc.
Newshore Financial Services Inc.
Securitus Capital Corporation
ABN Ambro
Barclays Bank
Deutsche Bank
HSBC Bank
UBS
BMO
BNP Parabas
CIBC World Markets
Desjardins Securities
Deutsche Bank Securities
HSBC Securities
Laurentian Bank Securities
National Bank of Canada
RBC Dominion
Scotia Capital
Societe Generale Securities
Davies Ward Phillips & Vineberg
McCarthy Tetrault
Ogilvie Renault
√ Apollo Trust 1 1 1 1 1 1
√ Apsley Trust 1 1 1 1 1 1 1 1
Aria Trust 1
√ Aurora Trust 1 1 1
√ Comet Trust 1 1 1 1 1 1
DBRS Devonshire Trust 1 1 1
Encore Trust 1
√ Foundation Trust 1 1 1 1 1 1
√ Gemini Trust 1 1 1 1 1 1
√ Ironstone Trust 1 1 1
MMAI-I Trust 1 1
Newshore Canadian Trust 1
√ Opus Trust 1 1 1 1 1 1 1 1 1
√ Planet Trust 1 1 1 1 1 1 1 1
√ Rocket Trust 1 1 1 1 1
√ Selkirk Funding Trust 1 1 1 1 1
√ Silverstone Trust 1 1 1 1 1 1 1 1
√ Skeena Capital Trust 1 1 1
√ SLATE Trust 1 1 1
√ Structured Asset Trust 1 1 1 1 1
√ Structured Investment Trust III 1 1 1 1 1
√ Symphony Trust 1 1 1 1 1 1 1 1 1
√ Whitehall Trust 1 1 1 1 1
8
Who Bears the Loss From Made-in-Canada Defective Commercial Paper?
Figure 3: Third Party ABCP Publicly Disclosed Owners
9
10
The Workout Process
On August 16, 2007, the Caisse de dépôt et placement du Québec brokered an agreement
amongst eight banks/investment banks and PSP Investments (Federal Public Service
Pension Plan) to a 60 day moratorium on owners calling default of the Third Party Paper
ABCP and on contract parties making margin calls and liquidity agreement calls.
Participants are seeking an extension of this moratorium, as announced on September 27,
2007. The signatories, to what became known as the Montreal Accord, are developing
detailed restructuring plans for the affected Third Party ABCP. The restructuring is
expected to involve the conversion of the short term ABCP into long term notes with
floating interest rates. The owners seeking to realize cash in the short term will likely
receive a purchase offer for these new notes brokered by one or more of the
banks/investment banks within the Montreal Accord group.
On September 6, 2007, the Pan Canadian Committee for Investors in Third Party ABCP
was formed. Purdy Crawford, a well known securities lawyer from Osler Hoskin
Harcourt, was hired as Chairman of this Committee. The members of the Montreal
Accord Group and Pan Canadian Committee are shown in Figure 4.
Figure 4: Pan Canadian Committee for Investors in
Third Party ABCP & Montreal Accord Signatories
Pan Canadian Committee for Investors in Third Party ABCP
6-Sep-07
ATB Financial
Caisse De Dépôt MA
Canaccord Capital
Canada Mortgage and Housing Corp
Canada Post
Credit Union Central of Alberta
Credit Union Central of Canada
Desjardins Group
Magna International MA
National Bank MA
Northwater Capital Management
NAV Canada
PSP Investments MA
MA - Original signatories of Montreal Accord
Montreal Accord Signatories
16-Aug-07
ABN Ambro
Barclay Capital
Caisse De Dépôt PCC
Desjardins Group PCC
Deutsche Bank
HSBC Securities
Merrill Lynch
National Bank PCC
PSP Investments PCC
UBS
PCC - Also on the Pan Canadian Committee for Investors in Third Party ABCP
11
What one notices about the Montreal Accord Group in Figure 4 is who is not on it. The
big five Canadian banks outside of Quebec are absent, while there are 6 international
banks/investment banks on it. Quebec's National Bank and Desjardins Group are in the
Montreal Accord Group. The counterparties to the credit default swaps and the
signatories of the liquidity agreements in the Third Party ABCP are not publicly
disclosed in the Information Memorandum for the problem conduits. Deutsche Bank and
Barclays Bank for sure, and probably the other 4 international banks, are signatories to
liquidity agreements backing the Third Party ABCP. Three of the ABCP conduits
disclosed that Deutsche Bank and Barclays Bank walked from their liquidity agreements
due to their opt out provisions. The other liquidity agreement signatories have either
already walked or are expected to walk too.
Deutsche Bank and HSBC Securities are also amongst the original distribution agents
listed in the Information Memorandum for the problem conduits as shown in Figure 2.
BMO, CIBC Markets, RBC Dominion, Scotia Capital, Laurentian Bank and Société
Générale Securities are distribution agents too, but they have not volunteered to be on the
Montreal Accord Group.
Half of the 12 member Pan Canadian Committee is government pension funds or crown
corporations. The Caisse De Dépôt and PSP Investments have not publicly disclosed the
amount invested in Third Party ABCP. On the other hand, ATB Financial, an Alberta
Government crown corporation, announced it holds $1.2 billion of Third Party ABCP.
The Ontario Government has publicly disclosed its exposure to Third Party ABCP at
$863 million, of which $700 million is at the Ontario Financing Authority, $103 million
at the Ontario Power Generation Corporation and $60 million at the Ontario Teachers
Pension Plan. Interestingly, there is no Ontario Government representative on the Pan
Canadian Committee membership list in the September 6, 2007 media release. The
Ontario Government election is on October 10, 2007 and perhaps there is concern about
Ontario's exposure becoming a high profile election issue.
Magna International joined the Pan Canadian Committee, as the sole corporate
representative amongst at least 29 public corporations, that have publicly disclosing their
ownership of the Third Party ABCP as noted in Figure 3.
Ernst & Young Inc. announced that holders of over 81 % of the outstanding Third Party
ABCP release have signed agreements or acknowledgements indicating their support for
the interim arrangements provided in the Montreal Accord.
Not a Controllable Situation Since Credit Default Swaps Not Covered By the
Companies' Creditor Arrangement Act
The Globe and Mail article written by Sandra Rubin, "Class-action guys see profit in
subprime mess," on September 5, 2007 says:
12
"Credit default swaps have become so pervasive in Canada that they're linked to about $25-billion of the
$40-billion of the outstanding third party asset-backed commercial paper, says a senior lawyer familiar with
events…. Here's the thing: Under Canadian restructuring law [Companies' Creditor Arrangement Act], you
can't stay a counterparty to a swap. By law, the parties who bought the protection can't be prevented from
exercising their rights…..If the swaps are in default, expect the climate to turn on a dime."
Canadian owners of the Third Party ABCP, and their millions of affected
Canadians, need to know the specific list of credit default swap counterparties and
signatories of the liquidity agreements. It appears that in virtually all cases, the banks are
on both sides of the equation, as a counterparty to credit default swaps and a signatory for
the liquidity agreement for the same conduit. There needs to be concern that the
banks put themselves into the powerful position of being able to make a call for cash to
pay for default damages under their swap, knowing that they would walk from their
liquidity agreement and gain access to the conduit's collateral of top rated assets held in
trust. These bank counterparties would then control the triggering of the crisis for the
Third Party ABCP owners in Canada, if there was widening of credit spreads due to
deteriorating credit conditions. At the same time, these banks would know that their own
interests were protected in their self made crisis by their first call on the top quality
collateral within the conduit.
Even in situations where a bank is not both a counterparty for a credit default swap and a
signatory of the liquidity agreement in the same conduit, one should question whether
two different banks knew about the other's role in the conduit and had access to each
other's detailed contract terms. Then, the two acting together have the same consequence
of one bank involved as counterparty of the credit default swap and liquidity agreement.
The international banks, without significant Canadian retail operations and Mainstreet
presence in Canada, would be the most inclined to participate in the scheme of being both
counterparty to a credit default swap and signatory to a defective liquidity agreement,
which is to the detriment of Canadian accredited buyers. These international banks
would not have the same reputation and business motive for voluntary offers to make
retail customers in Canada whole. The international banks could also benefit from the
weak Canadian regulatory regime governing defective investment products, its failure to
regulate international banks, and its undue onus on accredited investors to conduct due
diligence.
One further nuance about the rights of the counterparties to the credit default swaps held
in the Third Party ABCP conduits is their right to call for additional margin. The original
August 16, 2007 Montreal Accord media release attached gave subtle reference to the
problem that the Canadian Third Party ABCP conduits had received margin calls and
would receive further margin calls. The original media release does not, however, refer
specifically to margin calls arising from credit default swaps held in the conduits. It is
the margin call(s) that probably triggered the freeze-up of the Third Party ABCP market
in Canada. Once the word spread about credit default swap margin calls, there would be
no new buyers for the Third Party ABCP current owners who wanted to sell or get their
cash back on maturity.
13
A margin call to the conduits means that they need to add more cash/quality assets to the
collateral backing their liability to cover future default damages as prescribed in the
credit default swap. Then, if the additional margin is not put into the conduit, the
counterparty would have the immediate right to call the swap into default and take steps
to demand cash payment funded from their collateral. So, if there is $50 owing to the
counterparties at today's credit default swap price for every $100 of Third Party ABCP,
then it becomes payable today unless the conduit adds cash/quality assets to the collateral
balance. So, without new cash/quality assets added, the conduit does not have the luxury
of time for the credit default swap price to recover, when credit spreads narrow after
the world-wide credit crunch is over.
Office of Superintendent of Financial Institutions Permitted Defective
Liquidity Agreements
Julie Dickson, Superintendent of the Federal Office of the Superintendent of Financial
Institutions Canada (OSFI) spoke to the National Insurance Conference of Canada in
Montreal, Quebec on Monday, October 01, 2007. She responds to criticisms about the
OSFI B-5 regulation below, which clearly shows that OSFI permitted the banks to sign
what I call "the Made-in-Canada defective liquidity agreements" for the Third Party
ABCP.
OSFI B-5 Regulation says:
"Liquidity support is a commitment to lend to, or purchase assets of, an SPE in order to provide investors
with assurance of timely payment of principal and interest. Liquidity support may include a general market
disruption clause. A general market disruption can be defined as a disruption in the Canadian commercial
paper market resulting in the inability of Canadian commercial paper issuers, including the SPE, to issue
any commercial paper, and where the inability does not result from a diminution in the creditworthiness of
the SPE or any originator or from a deterioration in the performance of the assets of the SPE."
Julie Dickson has these excuses in her attached October 1, 2007 speech:
(1) Its not my job.
In assessing the comments that have been made, I have to note that it is not OSFI's role to use our powers
over banks (which are designed to help protect bank solvency) to regulate capital markets. As a prudential
regulator we do not tell Canadian investors what to invest in or not invest in. We do not tell unregulated
players how to go about their business. We do not tell banks to provide liquidity to certain players and on
what conditions.
In summary, OSFI focuses on the strength of the financial institutions because that is our job – safety and
soundness of institutions that make promises to pay depositors and policyholders. OSFI focuses on capital,
or buffers for the unexpected, as well as stress testing, liquidity and continual enhancement of monitoring
systems and risk management, as that plays a key role in maintaining a safe and sound financial system.
(2) Sophisticated investors should have known, and the S & P and DBRS had different
credit rating opinions.
14
4. Uniqueness of the Canadian ABCP market – The fact that Canadian investors were buying ABCP with
one rating and with limited liquidity lines was also known. S&P had put out reports explaining why they
would not rate a product that had liquidity lines that could only be drawn in the event of a general market
disruption (GMD or so-called Canadian style due to their popularity in Canada). S&P suggested that
liquidity lines that were more readily available in time of need (so-called global style lines) were better for
the investor. Others such as DBRS believed that GMD lines were sufficient given the higher level of credit
enhancement in Canadian structures compared to international structures. Sophisticated investors and
advisors supported the DBRS view.
(3) Our banks have fixed the problem now, by moving to the international standard for
liquidity agreements.
OSFI applied internationally agreed capital rules. The more risk of a liquidity line being drawn, the more
capital a bank had to hold (the charge was 10% for global style lines). Where the risk of a line being drawn
was extremely remote, the capital charge was zero. These are international capital rules. Despite headlines
suggesting lax rules, loose rules, or different rules, Canadian rules are robust and aligned with international
standards. Like all international banks, Canadian banks have stepped in to support their conduits, and this
has helped to bring back investor confidence. The banks have also announced a move to global style lines,
again to reassure investors.
So, now Canadians discover there is another regulatory agency that protects the major
Canadian banks, at the expense of no investor protection for investors. Even the OSFI
role to supervise and ensure the solvency of federally registered pension funds has taken
a back seat to serving the Canadian banks by allowing them to sign liquidity agreements
that they knew would have virtually no benefit to the ABCP pension fund owners. The
Federal Office of Superintendent of Financial Institutions has effectively assisted the
banks to skim fees from the ABCP conduits, which reduced the interest paid to the retail
investors, Canadian pension funds and corporations owning ABCP.
On the excuse that OFSI does not regulate the international banks who signed most of the
ineffective liquidity agreements in the 23 Third Party ABCP that are frozen, is Canada
open to all international banks who seek to make profits by skimming and misleading
Canadian retail investors and pension funds? Also, OSFI cannot promote the Canadian
banks to be "saintly" on the defective ABCP liquidity agreement issue. The Canadian
banks have indeed made voluntary offers to make retail investor whole on their own
Bank ABCP, but their investment bank subsidiaries are well represented amongst the
originating distribution agents for the problem Third Party ABCP sold to accredited
pension funds and corporations.
Standard & Poors Canada wrote a research report in 2002 called, "Leap of Faith:
Canadian Asset-Backed Commercial Paper Often Lacks Liquidity Backup." This 2002 S
& P report was prescient in predicting that the OSFI B-5 regulation would not protect the
Canadian banks as it was intended to do. Rather, the extremely limited use
liquidity agreement wording of B-5 would contribute to a market confidence contagion
within ABCP, if there became a need for the conduits to make liquidity calls. This is
what has just happened!
15
S & P 202 Report, "Leap of Faith," says:
"The Canadian market is unique in its acceptance of ABCP conduits with extremely limited-use liquidity
support. Why has this situation evolved? The arrangement was initially implemented in 1994 as the
sponsoring banks interpreted then-issued regulation B-5 of the Office of the Superintendent of Financial
Institutions (OSFI). Since then, the practice has become institutionalized among market participants.
OSFI's concern is with ensuring banking system stability, and the capital adequacy of individual banks. To
the extent a bank takes credit risk through the provision of a lending facility, OSFI requires the bank to
hold capital against that exposure. In B-5, OSFI makes an exception for liquidity lines to ABCP specialpurpose
entities. OSFI allows zero-capital treatment for a liquidity line if it is cancelable or reducible and
only available in circumstances of widespread market disruption."
"Interestingly, the overall effect of B-5 may be to exacerbate, not limit, bank-system exposure to credit
problems. Were a conduit able to rely on timely liquidity as funding support, this could preempt a conduitspecific
default, and avoid market confidence contagion to other conduits managed by the same sponsors,
or to conduits in general.
Nevertheless, given conventional Canadian liquidity support limitations, the liquidity might not be
available, and a conduit facing operational difficulties or incremental performance deterioration could face
a ratings downgrade. This, in turn, could lead to an outright default because the unavailability of liquidity
facilities coincidental with faltering market confidence would cause the conduit to be unable to roll over
maturing ABCP."
The Pan Canadian Committee Cannot Make the Pension Beneficiaries,
Taxpayers and Shareowners Whole
"Our Investor Committee will be looking to implement a solution that addresses the best
interests of investors generally, and at the same time allows for a successful restructuring
and a return to market stability for these investments", said Mr. Crawford who added that
"in considering the best interests of investors, I will be guided by my own views as to
fairness." (CNW Release, A Pan Canadian Committee Chaired by Mr. Purdy Crawford
will oversee Third Party Commercial Paper restructuring process, September 6, 2007.)
The Montreal Accord Group comprises the senior executives of banks/investment banks
who either signed defective liquidity agreements, or distributed defective investment
product. The Pan Canadian Committee comprises senior executives of investor
organizations, that were either personally negligent or duped into buying the defective
commercial paper.
Both the Montreal Accord Group and Pan Canadian Committee members are motivated
to cover-up their responsibility for the Third Party ABCP damages from the pension
beneficiaries, taxpayers and shareowners who will be paying for the damages. The
banks/investment banks want a quick solution to mitigate litigation risk and liability for
any damages associated with known defective features in the ABCP or any
misrepresentations on the characteristics of the product in the Information Memorandum.
The professional money managers want to protect their personal reputation and jobs and
16
they are not personally liable for the damages that will be borne by the pension
beneficiaries, taxpayers and shareowners.
There is a reasonable question about why the banks/investment banks who were either
negligent or intended to sell defective products unique to Canada, should be permitted to
be in the inner circle of investment banks putting together a restructuring offer where it is
likely that the owners will not be made whole. The pension beneficiaries, taxpayers
and shareowners need to be assured that the restructuring offer being presented is
the best offer available from all parties who may have an interest in the assets from
throughout the world. This can only be achieved by the creation of a long term
note, that has complete transparency on its underlying assets and that meets
international standards acceptable for resale in the international markets.
An inner circle of investment banks, especially those who may have been negligent
or deceitful, should not be permitted to make a discount offer to the owners needing
cash, with the intent to flip the restructured securities into the international fixed
income market at considerable profits for themselves. Such ill-gotten profit belongs
to the pension beneficiaries, taxpayers and shareowners, who would get this money
in a properly conducted public auction at the outset.
Urgent Changes Needed in the Workout Process
The Bank of Canada Governor David Dodge and Federal Finance Minister Jim Flaherty
have made statements supporting the Montreal Accord Group and the Pan Canadian
Committee, crediting the process as an orderly restructuring of the Canadian ABCP
market, that provides an opportunity for the affected parties to work through the many
complex issues related to the market.
But the process is seriously flawed because the Montreal Accord Group and Pan
Canadian Committee Members are made up of the people who need to "cover their asses"
and who are not paying for the loss - the pension beneficiaries, taxpayers and
shareowners are.
The Federal Parliament, through the Federal Minister of Finance, should appoint a
qualified independent monitor to ensure that the interests of the pension
beneficiaries, taxpayers and shareowners are being met in the decisions of the
Montreal Accord Group and Pan Canadian Committee. The pension beneficiaries
and shareowners should not be expected to enter subsequent civil litigation against
the managers hired to conduct duties on their behalf, in the event these managers
accepted a quick concessionary solution to cover up for their own negligence in
purchasing defective Third Party ABCP.
17
The purpose of the requested independent expert monitor appointed by the Federal
Government is to ensure that the damages to pension beneficiaries, taxpayers and
shareowners are mitigated.
(1) That there will be no quick opaque discount offer made by the vendor group ( = the
conduit sponsors and all contract parties) and accepted by the investment management
executives who bought the defective Third Party ABCP, in order to cover-up negligence
or deceit and to protect the reputations of the vendor group (including all contract
parties) and of the investment management executives.
(2) There needs to be a government monitor acting in the public interest in terms of
identifying any securities, competition or criminal law misconduct within the vendor
group and DBRS, whose knowledge and threat of enforcement would leverage a better
restructuring solution from the vendor group than otherwise. If there is sufficient
evidence of negligence or misrepresentation on the part of the vendor group, then
the pension beneficiaries, taxpayers and shareowners should be made whole.
(3) The public interest monitor must ensure that the Canadian Third Party ABCP owners,
and their millions of affected Canadians, know the names of the banks who are the
counterparties to the credit default swaps and the signatories of the liquidity agreements.
Bank counterparties in credit default swaps that have the right to call for cash payments,
should not be permitted to be an exclusive group entitled to make restructuring offers to
the Canadian Third Party ABCP owners, especially since when they were also signatories
for the Made-in-Canada defective liquidity agreements in the same conduits.
(3) Worse still, the inside vendor group cannot be allowed to make discount deals, only
to flip the notes acquired into the international fixed income markets for windfall gains to
themselves that belong to the pension beneficiaries, taxpayers and shareowners of
Canada. There needs to be a public auction for the purchase of the restructured
notes, where international fixed income asset buyers and investment banks are
permitted entry into the data room now and the opportunity to make fully informed
bids for each of the conduits.
(4) The independent government monitor must ensure that investment banking fees,
legal fees, accounting fees, stalking horse bid fees and any other fees not named are held
to reasonable amounts. Too much money is being spent on professional fees to mop
up problems caused by defects in investment products that were designed and
distributed by the same professionals. Employment for investment bankers, lawyers
and accountants manufacturing and repairing defective investment products is not
a good industry for Canada.
(5) Procedures must be adopted to ensure full transparency to the independent
government monitor or other agents for the pension beneficiaries, taxpayers and
shareowners. Bona fide agents for the pension beneficiaries, taxpayers and
18
shareowners need to be added to the Ernst & Young protocol for access to the data
room. The specific information requiring transparency is:
(a) the assets owned by the conduits that issued the Third Party ABCP;
(b) all material contracts, including liquidity agreements
(c) the features of the restructured long term notes;
( d) all investment banking, legal and accounting fees;
(e) the process for a public auction of the long term notes by the owners seeking
immediate cash.
A Final Word on Where Are the Securities Regulators?
Third Party ABCP is another Made-in-Canada defective investment product, which
demonstrates there is no investor protection for investors and pensioners in Canada.
Canadians are learning about Third Party ABCP losses in the wholesale market, just as
income trusts are stumbling into their own financial crisis of $11 billion losses to date
within the retail market. 26% of all income trusts have suspended or substantially cut
distributions due to this business model's flawed design and its reliance on deceptive
financial reporting.
The provincial securities commissions have adopted the principle that accredited
investors do not need investor protection since they are sophisticated and have
formidable power and resources to seek redress for negligence or malfeasance by
issuers or investment banks. But, the damages to pension beneficiaries, taxpayers
and shareowners from Third Party ABCP will be up to $20 billion. Such
unnecessary losses are bad for the country's economy and its already broken
reputation on securities regulation. Canada needs to adopt a national securities
regulator, with proper civilian oversight and effective enforcement.
The Ontario Securities Commission has taken advice from the issuers, investment bank
distributors and securities lawyers who design new investment products, rather than from
their own experts or retained independent experts. The OSC has a Commodity Futures
Advisory Board that consults with and advises OSC staff on: developments in the nature
of contracts and manner of trading; and, the influence of trading in contracts on the
economy of Ontario. All four OSC Commodity Futures Advisory Board participants are
directly involved in the vendor group for the defective Third Party ABCP.
David Ellins Coventree Capital Group Inc.
Carol Pennycook (Chair) Davies Ward Phillips & Vineberg
Stephen Elgee BMO Nesbitt Burns
Jim Sinclair Northwater Capital Management Inc.
Davies Ward Phillips & Vineberg is one of three legal firms that signed off on the 23
problem ABCP conduits listed in Figure 2. David Brown, the former Chairman of the
OSC and the Current Chairman of the RCMP Task Force on Governance and Cultural
Change, is a current Counsel with the firm Davies Ward Phillips & Vineberg.
19
Both David Brown, the former OSC Chairman, and David Wilson, the current OSC
Chairman, failed to detect since 2001 that DBRS was giving top investment grade ratings
to Third Party ABCP that did not meet the international standard for sound liquidity
agreements. Coventree Capital, Nereus Financial, Northwater Capital Management and
Dundee Securities are Ontario registrants. The OSC was not able to prevent the loss to
the Ontario Government that has publicly disclosed it exposure to Third Party ABCP at
$863 million amongst three entities.
Similarly, Jean St.-Gelais, Chairman of Quebec's l'Autorité des marchés financiers,
appears to have been oblivious to the significant participation of Quebec registrants in
defective Third Party ABCP: Caisse de dépôt et placement du Québec, National Bank,
Desjardins Bank Securities, Laurentian Bank Securities and Société Générale Securities.
Finance Minister James Flaherty is right to say that Canada should have a national
securities commission, so that it can be a better first responder to financial crises,
especially ones that are made in Canada and involve a market abuse. Indeed, there
are credit crunch problems throughout the world, where there is strong securities
regulation such as in the U.S. and the U.K. But, in those countries, government experts
and expertise funding are on standby to answer 911 calls from the owners of distressed
securities, who need well orchestrated and fair solutions. For sure, the private sector
players involved in negligence or deception cannot seize the agenda to act in their own
interests rather than the interests of the actual people suffering the damages, the pension
beneficiaries, taxpayers and shareowners.
The House of Commons Finance Committee must hold hearings on the lessons
learned from the Third Party ABCP fiasco and the general malfunctioning of
Canada's securities regulation and white collar crime enforcement system. The
hoped for outcome of this hearing would be a new Federal Government securities law
and a national securities commission. The existing investment industry SRO's and
provincial securities commissions have failed to protect Canadians once again. Average
Canadians can no longer afford to take more billions of dollar damages from Made-In-
Canada defective investment products and white collar securities crime.
Canada's top priority, however, is to develop a properly functioning independent RCMP
white collar crime police unit, that has the confidence of international police forces and
collaborates with municipal and provincial police forces throughout Canada. The RCMP
must discontinue its reliance on referrals for criminal investigations from the investment
industry SRO's and the provincial securities commissions.
Diane Urquhart
Independent Analyst
Mississauga, Ontario
Telephone: (905) 822-7618
Cell: (416) 505-4832